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NRT | The Carried Interest Debate | ||
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Jun 14, 2010 The Carried Interest Debate Upcoming Legislation Could Change The Tax Implications
Although Carried Interest may sound quite complicated, it only requires the understanding of a few very basic concepts.
As it relates to commercial real estate, Carried Interest, which, by the way, is a misnomer, is money which is paid to the General Partner (usually a firm) of a partnership that has invested, in this case, in commercial real estate. This money is actually a management fee, and if it is paid to the general partner, but not distributed to them until the property is sold, it is taxed differently than if it were paid and distributed at the same time. The tax law currently states that even if the general partner doesn’t put any capital into the deal (meaning it doesn’t invest any of its own money), when the property is sold, the general partner can use the capital gains tax rate, 15%, rather than the income tax rate, which can be as high as 35%, when calculating their tax liability.
General partners are usually the ones managing the day-to-day operations of the partnership (as opposed to limited partners who are the actual investors) and are paid from the profits generated from the project, whether those profits come from the operations or sale of the property, or both.
The controversy stems from the fact that, in all actuality, the income the general partner receives is not capital gains…it’s income.
If the legislation passes, the tax rate on carried interest would rise from the current 15 percent to 35 percent—the current highest income tax rate. However, should current tax cuts expire in 2011, the tax rate would be even higher—39.6 percent. The bill, HR 4213, the “American Jobs and Closing Tax Loopholes Act”, passed the House of Representatives in mid May. The expectation is that the Senate will consider the legislation in the coming weeks with the goal of getting a final bill to President Obama’s desk before July 4. By that time, the wording of the law may yet change many times.
Senators are reportedly discussing limiting the carried interest tax rate for assets held longer than seven years to 31 percent. Assets held for a shorter period would be taxed at 33 percent. If the legislation is passed, it would be applicable starting in 2011. But market analysts say it will be at least until 2012 or 2013 before the Internal Revenue Service will be able to adapt the measure and start applying it in real life. If that is indeed the case, the industry will have some time to continue its recovery and adjust for the law’s enactment.
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